Nortel plays the numbers game

Wondering how Nortel could lose so much money in such a short time? Join Dave as he looks at the company's balance sheet.

NET KNOW-HOW WITH DAVE KEARNS

By Dave Kearns

Nortel plays the numbers game

Last month, I mentioned some of the types of stories you could expect me to write in this space -- and I led that off by mentioning Nortel and how they lost $19 billion in the second quarter of this year. Predictably, one of the first responses I got asked where that story could be read. At the time, it couldn't -- because I hadn't written it yet. Today, you can read more detail.

First, though, I need to tell you about my understanding of finance. Ten years ago, when -- as IT director-- I introduced e-mail to my company, I observed a strange phenomenon. Our VP of Sales would have his secretary print out every one of his e-mails and bring it to him. He'd read it, write his response at the bottom, and give it back to her to actually type in the reply. I observed reasons for this: 1) he didn't believe executives should be typing and 2) he really did not understand the technology.

When it comes to finance, I really don't understand its intricacies and I don't believe intelligent people should be doing mind-numbing addition and subtraction. (And, anyway, my wife won't let me balance the checkbook!) If you really want to know the details of what happened at Nortel, I can't explain them to you. I can, though, give you a logical look at what's been reported and let you decide if it makes sense.

By the way, Nortel has actually reported a loss of over $30 billion dollars for the first two quarters. That's over $5 billion a month, almost $350 million a day. Take a stack of $1000 bills. Throw four of them out the window every second of every minute of every hour of every day for six months. That's seemingly what Nortel did. You'd think somebody would notice.

Now when I talk about a loss, it means I paid out more than I took in. For Nortel, in the second quarter, their operating expenses were $1.5 billion more than their revenue (I think that's what "pro forma net earnings" means). But if that's so, where did the other $17.5 billion go? Did someone walk off with the petty cash?

No. That would be easier to understand, at least for me. In fact, the losses are the dying gasp of the dot-com bubble burst.

Nortel, like many old-line voice communications companies, had the desire to be at the forefront of the burgeoning data communications market. There are two ways to break into a new market: hire expertise and grow your own products, or acquire an existing company. With the stock marketing spiraling upwards at ever more dizzying rates, Nortel was very cash-heavy -- at least on paper. Acquisitions were financed by stock swaps, which appeared to be essentially a free ride -- if the stock doubles in price and I give you 25% of it for your company, then I have both your company and stock worth 50% more than I paid for it. Wow! Money for nothin', and the company for free!

So what happens is that a company (we'll call it "company N") agrees to acquire another company (say, "company X") for $40 billion in stock. Company X has only $5 billion in assets (real estate, hardware, inventory, desks, etc.) so $35 billion is called "good will" (e.g., the domain name companyX.com). By the time the paperwork is done, the various governments and shareholders have approved the acquisition and (oh, by the way) the stock market has fallen. Company N's stock swap is now only worth $20 billion. But (and here's were I get lost) the good will is somehow still carried at $35 billion! Now the assets may still be valued at $5 billion, so there's now $15 billion in current good will, minus $35 billion in announced good will -- that's 20 billion that has to be accounted for. Corporations do this by reporting it as a loss, usually spread over five years or so, but occasionally (like Nortel) accelerating the reporting. It's like telling someone all the bad news at once to get it over with.

So, much of the $30+ billion in losses Nortel reported so far this year aren't "real" losses; they're just accounting maneuvers required by financial managers as a way to keep bookkeepers employed.

But, speaking of employment, if Nortel really didn't lose $30 billion, then why did they need to unload over 7000 workers? Ah, but that's a story for another day.

Do you agree with Dave's math? Post your comments in Dave's discussion forum.

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This was first published in August 2001

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